article 3 months old

The Wrap: Insurers, Fund & Wealth Managers

Weekly Reports | Jan 25 2019

This story features INSURANCE AUSTRALIA GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: IAG

Weekly Broker Wrap: general insurers; health insurers; fund managers; wealth managers; Labor policy; and building materials.

-Heightened probability of greater insurer oversight and increased disclosure requirements from RC report
-nib better placed to manage a cap on health insurance premiums
-Challenging market conditions for fund managers
-Higher remediation charges likely for wealth managers
-Interest rates and China's outlook likely to be the driver of Australian markets, not ALP policy
-JPMorgan prefers building stocks with earnings leverage to offshore markets

 

By Eva Brocklehurst

General Insurers

Macquarie believes the risks surrounding the regulatory reviews of insurers are not incorporated into consensus earnings forecasts. Additional costs for both Insurance Australia Group ((IAG)) and Suncorp ((SUN)) could lead to -5-10% downgrades to earnings per share, if implemented fully. The Hayne Royal Commission final report is due for submission to the government by February 1.

The Royal Commission has highlighted a number of case studies where cash settlement was suggested by insurers when it may not have been in the best interests of the customer. Macquarie believes the likely outcome could be that the industry adopts a higher rebuild proportion of claims as best practice to avoid further regulatory oversight.

The broker believes there is a high probability of greater powers for oversight bodies as well as increased & simplified policy disclosure, and guidelines on appropriate customer segmentation. These are potential headwinds for the former two companies, and to a lesser extent QBE Insurance ((QBE)).

General insurance remains Morgan Stanley's most preferred exposure in the sector amid the uncertainty that overhangs wealth managers and the outlook for downgrades to health insurers. The main attractive features are improving top-line growth, margin expansion in commercial/SME lines and strong balance sheets.

The broker believes IAG's investment case is robust. Margin guidance is expected to be reiterated, despite the December hailstorm in Sydney. Morgan Stanley believes Suncorp's 10%-plus cash returns target was always going to be a stretch and elevated catastrophe budgets now make it more unlikely. Despite the risks, underlying margins in the company's general insurance division are expected to show improvement.

Health Insurers

Morgan Stanley believes a 2% cap on premium increases for private health insurers in 2020 and 2021 is now the most likely outcome. Private health has has emerged as a key area of debate for the upcoming federal election. The broker forecasts net margins to fall to 5.4% in FY22 for Medibank Private ((MPL)) from 8.0% in FY19. Margins are expected to fall to 4.5% for nib's ((NHF)) ARHI division from 6.4%.

Morgan Stanley also notes that a number of well capitalised, unlisted insurers are budgeting the negative margins from FY20. The broker assesses, with 40% of earnings in unregulated businesses, nib Holdings ((NHF)) is better placed to manage this development. Medibank, on the other hand,  is less so as it derives 90% of earnings from regulated profit pools post the loss of the ADF contract.

Fund Managers

Challenging market conditions characterised the December quarter for fund managers, Macquarie observes. Market performance reduced funds under management by -6-8% across the sector and flows continued to be stock specific. Magellan Financial ((MFG)) produced consistent retail inflow during the quarter and its relative performance to the market was strong. Macquarie retains an Outperform rating although recognises the stock may have captured some of the potential upside.

The broker expects flows for Pendal Group ((PDL)) to improve more broadly and this is now its preferred exposure in the sector. Meanwhile, there is limited scope for near-term relative outperformance at Perpetual ((PPT)) and Macquarie maintains a Neutral rating. Platinum Asset Management ((PTM)), also Neutral rated, has downside risk for near-term flows, in the broker's view.

CLSA has initiated on the sector, noting revenue is largely dependent on the outlook for assets under management, which are likely to grow strongly over time. CLSA forecast 7% compound growth rates in 2020-25, underpinned by active specialty management and alternatives. Active management is expected to remain a growth story in strategies that move away from index tracking and large market-cap benchmarks.

The broker rates Magellan Financial and Janus Henderson ((JHG)) Outperform, noting an excellent track record in the former and strong medium-term prospects for a re-rating in the latter. Underperform ratings are allocated to Pendal Group, Perpetual and Platinum Asset Management.

The broker is concerned about the near-term earnings revisions for Pendal Group and anticipates expansion of Perpetual's investment division will come at a cost. Market volatility is also expected to weigh on Platinum Asset Management.

Wealth Managers

Macquarie observes wealth companies, besides IOOF ((IFL)), have made material provisions for remediation across their adviser networks. Estimating the additional level of remediation expenses is difficult and the broker recognises the margin of error could be significant. Macquarie estimates the overall level of remediation charges over the next four years may reach $400m-1.5bn.

AMP ((AMP)) is likely to need to increase remediation, potentially by around $1.5bn in addition to the $778m that has been recognised. The broker considers IOOF's guidance for $5-10m in remediation is insufficient and there is a potential to recognise around $600m. The broker has $300m incorporated into its valuation.

Following recent asset sales AMP has additional capital flexibility but would have to liquidate some of the income-generating assets impacting investment income. The broker believes OnePath custodians will block the IOOF acquisition of the Pensions & investments business. In this scenario, IOOF would comfortably fund any remediation expenses.

If, however, the transaction were to go ahead, and debt was used, this would increase net debt to operating earnings (EBITDA) to elevated levels of around 2.0x. This could put pressure on IOOF to raise equity at a material discount.

Labor Government

Morgans identifies the potential impacts from Labor policies, should the party win government of the next federal election. Key policies would assist in financing higher public-sector expenditure and contain the budget but are considered attacks on investment. Proposed changes to negative gearing are a risk to an already softening housing market, the analysis contends.

This is the most dramatic impact Morgans identifies but would not be surprised if the policy was dropped, as proposed changes are likely to prove unpopular with home owners.

The proposal to scrap cash refunds of surplus franking credits may bring forward the plans by corporates with large franking balances to buy back shares and/or pay special dividends. Those with the potential to release surplus franking credits via buybacks or special dividends include Woolworths ((WOR), Wesfarmers ((WES)), JB Hi-Fi ((JBH)) and Flight Centre ((FLT)).

The analysis notes many proposals have been watered down since they were first announced and, while these may have alter the relative appeal of some asset classes, ultimately the larger forces such as normalising interest rates and China's outlook will be the dominant driver of Australian market fundamentals and returns. Morgans believes policy risk is already priced into some sectors, such as the banks.

Building Materials

The background for Australia's building materials sector has become more challenging, as residential construction is pulling back and the US housing market has softened. Activity in New Zealand appears set to moderate. JPMorgan prefers stocks with valuation support and earnings leverage towards offshore markets such as Boral ((BLD)), James Hardie ((JHX)) and Reliance Worldwide ((RWC)).

Meanwhile, as Adelaide Brighton ((ABC)) and DuluxGroup ((DLX)) have reached price targets, ratings are upgraded to Neutral. Still, JPMorgan is cautious about the outlook for these two as well as CSR ((CSR)) and Fletcher Building ((FBU)).

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

FNArena is proud about its track record and past achievements: Ten Years On

Share on FacebookTweet about this on TwitterShare on LinkedIn

Click to view our Glossary of Financial Terms

CHARTS

ABC BLD CSR FBU FLT IAG IFL JBH JHG JHX MFG MPL NHF PDL PPT PTM QBE RWC SUN WES

For more info SHARE ANALYSIS: ABC - ADBRI LIMITED

For more info SHARE ANALYSIS: BLD - BORAL LIMITED

For more info SHARE ANALYSIS: CSR - CSR LIMITED

For more info SHARE ANALYSIS: FBU - FLETCHER BUILDING LIMITED

For more info SHARE ANALYSIS: FLT - FLIGHT CENTRE TRAVEL GROUP LIMITED

For more info SHARE ANALYSIS: IAG - INSURANCE AUSTRALIA GROUP LIMITED

For more info SHARE ANALYSIS: IFL - INSIGNIA FINANCIAL LIMITED

For more info SHARE ANALYSIS: JBH - JB HI-FI LIMITED

For more info SHARE ANALYSIS: JHG - JANUS HENDERSON GROUP PLC

For more info SHARE ANALYSIS: JHX - JAMES HARDIE INDUSTRIES PLC

For more info SHARE ANALYSIS: MFG - MAGELLAN FINANCIAL GROUP LIMITED

For more info SHARE ANALYSIS: MPL - MEDIBANK PRIVATE LIMITED

For more info SHARE ANALYSIS: NHF - NIB HOLDINGS LIMITED

For more info SHARE ANALYSIS: PDL - PENDAL GROUP LIMITED

For more info SHARE ANALYSIS: PPT - PERPETUAL LIMITED

For more info SHARE ANALYSIS: PTM - PLATINUM ASSET MANAGEMENT LIMITED

For more info SHARE ANALYSIS: QBE - QBE INSURANCE GROUP LIMITED

For more info SHARE ANALYSIS: RWC - RELIANCE WORLDWIDE CORP. LIMITED

For more info SHARE ANALYSIS: SUN - SUNCORP GROUP LIMITED

For more info SHARE ANALYSIS: WES - WESFARMERS LIMITED